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    New Zealand dollar rallies amid RBNZ reluctance to cut rates on house price concerns

    The Reserve Bank of New Zealand (RBNZ) kept the official cash rate unchanged at 2.25% for the second straight month at its monetary policy meeting today. The decision was in line with most economists’ forecasts although some had expected another cut to follow March’s 0.25% reduction.

    The disappointment that the RBNZ did not surprise with another cut was coupled with a slightly less dovish than expected statement by the central bank. In today’s statement, the RBNZ said house prices in Auckland (New Zealand’s largest city) are at “very high levels” and that the rising prices pose a risk to financial stability.

    Markets interpreted this as a sign that the RBNZ may not be as eager to lower rates again, having cut them five times by 25bps each June 2015. The New Zealand dollar, which had already been rallying since the end of May on rising commodity prices and a weaker US dollar, jumped by 1.7% to 0.7116 versus the greenback immediately after the announcement. It later extended its gains to a one-year high of 0.7146 before settling around 0.7100 in mid-European session.

    The New Zealand dollar has now risen by almost 4% against its US counterpart since the start of the year but whether the bullish trend will hold is unclear. Contrary to market reaction, the RBNZ still maintained an easing bias in today’s policy statement as it remains concerned at the very low inflation level (0.4% in Q1) and the current exchange rate, which the Bank views as “higher than appropriate”.

    In fact, one of the factors that the RBNZ is counting on for inflation to pick up is for the kiwi to depreciate further. It should also be noted that although higher commodity prices in general are currently supporting the kiwi, the price of New Zealand’s main export – dairy, remains near multi-year lows. This is hurting the income for the country’s farmers, which is likely to continue to impact GDP growth in the coming quarters.

    First quarter GDP figures are not due until June 16 and this should shed some light as to how the New Zealand economy fared in the first few months of the year. With most economists expecting another cut by the third quarter, the RBNZ is likely to keep a close watch on short-term inflation expectations and whether the stronger exchange rate is starting to hurt exports in its future decision making. As for the overheated housing market, the RBNZ may decide to follow the Reserve Bank of Australia’s lead to use macro-prudential tools to tighten lending in the sector.

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